Microsoft Buys Skype for $8.5 Billion

Microsoft (MSFT) announced that they will buy Internet company Skype for $8.5 billion after the assumption of debt. This is the biggest acquisition in the company’s history, ahead of its 2007 purchase of online advertising company aQuantive for $6 billion. The price is certainly steep (roughly 10x sales) for a profitless company, and one that was purchased for 70% less six years ago by eBay (which sold a 65% stake in 2009 to a group of PE/VC firms). With the price in question, the company’s integration in the Microsoft system isn’t catching rave reviews either; here is what Charles Arthur, technology editor at the Guardian, had to say:

“After paying $8.5bn for Skype, what will Microsoft end up with? In a few years, I forecast it will be this: $8.5bn less in its bank accounts, a cats-in-a-bag fight between its Office division and its Online Services division over integration of the service, little – if any – kudos from consumers, and no appreciable effect on its bottom line.

That's right: Steve Ballmer, Microsoft's chief executive, might as well have put the money on a bonfire for all it's going to do for the company's share price, which has barely shifted in his 11-year tenure… It's about Ballmer's long-term aim to make Microsoft back into a hit brand with consumers, a position that it last held with the launch of Windows 95 in August 1995.”

There are a whole slew of negatives that Mr. Arthur sees from this deal. On the positive side, he can only imagine two ways this works for Microsoft. The first is a couple years down the road, when everybody has a smartphone in their hands, and can do voice-over-internet calls via Skype. The second is Skype integrated in Office, which could be a lock on businesses that already use the service (for voice and video conferencing capabilities).

When we get to hear management talk about the deal (press conference scheduled for 11 a.m. today), it should hopefully provide us with a better picture for the merits of this acquisition. The market has responded negatively, sending shares more than 2% lower in pre-market trading.

When all is said and done, this certainly teaches me a lesson about why investors without extensive experience in the industry should shy away from technology. When PepsiCo (PEP) bought Wimm-Bill-Dann, I had a good idea what I was paying for, and whether or not the deal made sense; the same can be said for when Johnson & Johnson (JNJ) recently bought Synthes. With the Skype deal, I'm left to value eyeballs, synergies and future expectations – three things I'm decidedly poor at deciphering or putting a number on. In the end, management better present a pretty convincing argument for why Skype, and why now.

About the author:

Alex Morris

I am a recent graduate from the University of Florida; I received a finance degree as well as a real estate minor during my time at UF. I will be sitting for Level 1 of the CFA Exam in December 2011, as well as for my series 65 exam. I am a value investor, plain and simple.

As you pointed out, eBay sold a 65% stake in Skype in 2009 for $2 billion. If Microsoft thinks Skype is such a great combination, it should have done something about it then. I am very disappointed with Mr. Ballmer's capital allocation here.

This deal is being universally panned. I agree that the price is a head scratcher. The fit is a good one, though. Skype doesn't currently run display adds, either. Could be a huge addition to it's earnings. Since they're going to run it as a wholly separate division - we'll get to see exactly what kind of difference advertising makes to the bottom line.

Certainly not cheap; wich leads me to believe (hope?) that Skype has a high strategic value for MSFT.

Skype could be the corner-stone of an All-IP mobile phone service from Microsoft; translating the same business model from Skype to a mobile device. Very cheap communications: free (worldwide) Skype to Skype, and very cheap for calls to other phones (including international). Users would paid a flat fee for mobile Internet access (That could be shared to other mobile devices trough personal HotSpot or some other manner). Which telecom operator will be willing to bring something like this into its network? None.

It's possible that Microsoft is aiming for Skype to become a Virtual Mobile Network Operator (a la Virgin Mobile). There are roughly 60 MVNOs in US and it's a common practice around the world with most european countries having a few.

The value proposition of Skype changes completely in this scenario. I imagine a mobile offering with Nokia / Windows Mobile phones with Skype technology highly integrated into the OS, in addition many Microsoft services (and from partners) will be integrated: Bing, Exchange, Hotmail, Office, Live, Facebook, Music, etc. Not a bad value proposition for customers, and not a bad scenario for Microsoft either. This could create (if well executed) a mobile device offering in par to Android and iPhone.

Microsoft seems to already have all the main components for a MVNO: Customer Service, Sales, Marketing, Brand Name Recognition, and Technology.

I might be over optimistic about Microsoft's plans but I can't phantom they paid 8.5bn just to replace something they already have in MSN Messenger / Windows Live. I guess that time will tell.

What surprises me is how much they paid for it. It is not like people were breaking down the doors at eBay for Skype was there?

I wouldn't be surprised if some executives at MSFT are "going to want to spend more time with their family" once Balmy Balmer and Co. actually get down to looking at the cost of this deal in retrospect.

As others have noted though Skype, as of this moment, has a pretty good moat so it is cheaper to buy than create their own chat/video/conference infrastructure.

But as a share holder, I think Skype is critical important for Windows Phone, X-Box ,etc.

X-Box and business software is not my expertise,I know a lot about software and smart phones though.

After all the operators built their 3G networks, all of them trying to push Video Call over 3G,

with little success, in many countries completely failure.

The first 3G Video calls in N.A was launched in Canada by Rogers Wireless back in Apr, 2007.

When I saw the phone and plan, I know it won't work, it just does not make sense,

who do you calling from/to?

Now Microsoft will link Skype to Live message, to X-Box live, then WP7, right now is about half billion users in this platform, after Nokia ship WP7 by volume and some growth in Skype, Live message, very soon the platform will have 1 billion active users.

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